REGULATORS SHOULD PREPARE contingency plans to protect financial markets from serious disruption if one of the Big Four audit firms were to collapse, the head of a group representing finance directors at the UK’s largest companies told a House of Lords inquiry yesterday.

The Big Four firms scrutinise the accounts of 99 companies in the FTSE 100, raising concerns that financial markets would be seriously disrupted if one of the them were to collapse.

Ashley Almanza, the finance director of gas company BG Group, and outgoing head of the Hundred Group of FDs, told the Lords committee examining the audit industry that regulators should have a contingency plan to “assist the transition of audit clients to auditors” if one of the big four firms were to collapse.

Asked why banks’ auditors had not issued warnings about the banks’ ability to continue as going concerns only months before the banks were bailed out by the government, Almanza, stressed that he was not an expert in the banking industry, but said: “This is a proper question. It needs to be looked at specifically by the Audit Inspection Unit, or by another [regulatory] body, which can pick up these audit files.”

His comments came as governments and regulators examine a series of proposals to improve competition in the audit industry and to regulate auditors more closely.

The European Commission (EC) is considering a mandatory rotation of auditors and a cap on advisory fees, as part of its investigation into the audit industry following the financial crisis.

In the UK, the Financial Services Authority, the City regulator, has proposed compulsory auditory rotation to improve competition in the market. Many companies rarely change their auditor, which it’s argued, can mean that auditors become too cosy with their client, particularly if the auditor is also providing lucrative consultancy work to the same client.

Pressure for change is also coming from some accountancy firms. Grant Thornton, the UK’s fifth-biggest accountancy firm, has called for limits to be placed on the number of listed companies that any one firm could audit in the UK.

There has been talk of major reform to the audit industry for decades, of course, but change has moved at a glacial pace. The Big Four firms have provided highly effective lobbyists, and audit reform has not been a priority for politicians.
Finance directors appear fairly happy with the current system.

When asked by the Lords committee about the Big Four firm’s dominance of the audit market, the FDs – from companies including Shell, the oil company and Pearson, the publisher – argued that the biggest audit firms were well equipped to deliver high-quality global services.

One FD said that mid-tier firms would have to invest heavily in order to become big enough to compete with the Big Four firms for the largest audit contracts.

Almanza (pictured) said he was concerned about some of the audit reforms being considered by the EC, including auditor rotation. “More regulation is not necessarily better,” he told the inquiry.

But Almanza said that he would welcome more competition in audit market. “I certainly do not want to see the Big Four go to the Big Three, and I would certainly welcome a Big Five.”

Mid-tier firms could compete against bigger rivals by merging or forming networks of firms, he said.

The FDs were broadly supportive of the audit industry’s performance.

When a peer on the committee asked the FDs whether they were worried that auditors’ handling of bank audits raised doubts about their professional judgment, Robin Freestone, chief financial officer at Pearson, responded that it was up to company management to define the “risks and uncertainties” their business faced – not the job of the auditor.

Peers also questioned FDs about the role of mark-to-mark accounting, a controversial accounting rule which forces banks to value some financial assets at the current market value. During the banking crisis, when markets were illiquid and asset prices were at rock bottom, this required banks to report big losses on some assets. Critics said that mark-to-mark accounting worsened the banking crisis.

Lord Lawson, a member of the Lords committee and former chancellor, said that mark-to-mark accounting was like a “doomsday machine” during the banking crisis, when market prices were “already underwater.”

Auditor checklist

What do finance directors want from their auditor? Despite the tough economic climate and pressure on companies to cut costs, FDs told peers that the price of an audit was not a deal breaker.

Being able to trust their auditor’s judgment and the accuracy of numbers in the annual report, are more important, FDs told the committee.

Auditors can also help company boards assess their performance by providing them with insights into how other companies do things, without giving away commercial secrets, the FDs said.

“Auditors can help us benchmark our management, for example, by ranking our management team from one to 10 against the rest of the industry,” said Almanza.